Merged Currency

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Merged Currencies

A merged currency is a common currency shared with one or more nations. It has some of the advantages and disadvantages of a fixed exchange rate system:

Exchange rate certainty

A merged currency provides exchange rate certainty.
There is no foreign exchange risk between the countries in the merged currency and this certainty can help to encourage trade.

Loose monetary policy as a tool

A disadvantage of a merged currency is that each nation loses the ability to use monetary policy to change their economic outlook.
E.g France cannot lower interest rates to increase aggregate demand (AD) and stimulate demand in expansionary monetary policy because the European Central Bank controls the Euro interest rate.

Regional differences

European Central Bank (ECB) determines monetary policy for the euro and has representatives from all nations.
But the ECB's decision on rates will not always line up with what is best for the economy of an individual country within it.
- Greece may have high inflation and need higher interest rates and France may have low inflation and need lower interest rates, but the ECB cannot do both.

Political risk

Fixing a currency at a 'low' rate to make sure that exports are competitive could cause conflict with trade partners who find themselves to be uncompetitive.
The US is currently trying to address it's perceived trade imbalance with China, caused in part by the Yuan being kept weak by China buying US dollars.
Although the US and China aren't in a merged currency, this could happen between countries in Europe.

Advantages of a Currency Union

A currency union involves two or more countries sharing the same currency. A prominent example of this is the Eurozone (within the EU). Some advantages of a currency union are:

Trade stability

There will be an improvement in the stability of trade between member countries of the union.
This is because prices won't be affected by changes (or fluctuations) in the exchange rate.

Increased investment in other nations

Nations can be more certain about investing in other countries in the currency union because their investments will not be exposed to FX risk.

Lower transaction costs

Transaction costs can often reduce welfare.
In a currency union, transaction costs for imports and exports are likely to be lower as there is no need to change currency.
Although businesses like TransferWise and Revolut have reduced international transaction costs in some markets.

Encourages fiscal responsibility

To join the Eurozone currency union, governments must meet criteria with their fiscal policy.
Countries like Greece did not maintain discipline and had very large fiscal deficits after adopting the Euro.

Disadvantages of a Currency Union

A currency union involves two or more countries sharing the same currency. A prominent example of this is the Eurozone (within the EU). Some disadvantages of a currency union are:

Lose monetary policy as a tool

The currency union takes control of the monetary policy for the union as a whole. So individual countries lose autonomy.
The central bank will choose policies which should benefit the union as a whole but that could reduce a country's ability to respond to shocks in their own economy.
If unemployment is 30% in Greece, but 2% in France and Germany, the European Central Bank is unlikely to cut interest rates (use expansionary monetary policy) to reduce unemployment in Greece because it may lead to excess inflation in France and Germany.

Different economic make-up

If the countries’ economies are too different, then the appropriate value of their currency may be different from that of the union as a whole. This could slow down that country’s growth and harm other objectives.
If the Euro is valued too highly, nations like Greece and Portugal may find that their exports are uncompetitive.

Entry costs

There can be initial costs in joining a currency union to prepare firms and households for the change.
This may be through tighter monetary or fiscal policy in the build-up to joining.